So you know it’s the right time to raise now who should you raise from? Knowing the different types of investors and sources of early stage capital is critical to a successful fundraising campaign. Let’s break down the list of the most common early stage investors and early stage sources of capital.
Friends and Family (F&F)
Venture Capital Funds
Non traditional funds (RBIs, Equity Buy Back, etc.)
There are so many different ways to raise money and so many different sources to go to but, the most important thing is understanding who you are talking to. You need to understand what motivates them and how should you get in touch.
Friends and Family. Now, before we get into this – let us just say that, we fully recognize not everyone has friends and family with access to wealth. This notion that founders can raise their first round of funding from F&F is born out of bias – bias that many investors have. We are not one of those investors. We recognize many founders don’t have that type of leverage. BUT, because it is one option, we are going to cover it. Friends and Family are just that, friends and family. These are people who may have a little bit of extra money, and because they love you, they are willing to give it to you to pursue your dream. Now, let's be honest. Your F&F are probably not going to relate you as the next Jeff Bezos or Sara Blakely. But they love you, so they want to give you that money because they see that you have conviction and want to support you. Don’t take advantage of them. Only take money from people who can afford to lose it. Because, let’s be real, the likelihood of you losing every single penny they give you – is very real. Let that sink in. This is not a reflection of you –most startups that raise VC never produce a return. Are you okay with the possibility of never returning this capital to your friends and family? If you do end up taking capital from F&F don’t be a jerk. Don’t take their capital on an unrealistic valuation. “Yes, grandma, I’m going to take in this $20,000 on a $20 million dollar valuation”. In fact, don’t do that regardless of who you take your first check from. Setting a very high price can hurt you in future rounds. Be fair.
Accelerators. There are for profit and non-profit accelerators. For profit accelerators are basically investors with education programs. StitchCrew is a non profit accelerator. Even though we don’t invest, we try to make it cheaper and faster to launch a company by sharing everything we know and helping founders avoid mistakes. Now, the thing to keep in mind with accelerators is that there are thousands of them and you want to make sure you pick the right one for you. This is especially true if they are for-profit accelerators that are going to want an equity stake in your company. Now a days, a lot of accelerators are run by academics or entrepreneurship enthusiasts who may have great intentions but, they have no true experience starting a company or investing in one. While this can be well intentioned, it can also hurt you when it comes to fundraising. Investors love to see dynamic companies who are constantly making progress. If you graduate from an accelerator and it didn’t help you accelerate, investors are going to start doubting your ability to perform. The other mistake we see founders make when it comes to accelerators is that they go through multiple accelerators just to get multiple checks, or perks or to put logos on their website. This is not helpful – if you need that much help getting your startup going – you may have bigger problems. Think very carefully before applying to an accelerator, some accelerators can be very helpful, but they are not necessary to achieve success.
Angels. Angels are basically wealthy people who like to invest in early stage startups. A lot of angel investors became angels because they were once a founder, they sold their company and they now have capital to invest in other companies. Those often turn out to be good investors because they get it, they’ve been there. While VCs get most of the glory, most first checks for startups actually come from angel investors, not VCs. Your job is to figure out how to identify angels and get a hold of them. Angels are usually very approachable because again, they like to invest in startups. They are always looking for deals and for the most part they are always willing to listen. The only thing we would caution you about Angels – is that you should be careful with angel groups. There are good angel groups that actively invest and have member stipulations that require members to actually write checks on a consistent basis. And then there are angel groups that exist only for the purpose of creating an “investor club.” These groups get together every month or so, they find a few entrepreneurs to pitch only to grill new founders, and the worst part is they rarely ever invest. It becomes a sport for them. Before you take a meeting with these type of groups, or any angel really, make sure they are actively deploying capital. Do some research ahead of time and don’t waste your time if they are not actively deploying capital. Time is money you don’t have and can’t afford to waste.
Seed Funds. Seed funds are often comprised of professional angels, who have raised outside capital to invest in early stage companies. They raise money from other angels who don’t have the time for all the due diligence or enough money to invest in larger funds. These are usually newer but professional investors who, for the most part, are great to work with because they understand they have to move quickly in order to help founders. They are pretty active in finding deals and building relationships. Their job is to find good deals and take meetings so they are pretty approachable. Figure out who they are and send them an email. If you can get a warm intro, great, but you don’t really need one. Remember, these are professional investors that are looking for significant returns so they can raise their next fund. They are not going to invest in small businesses or lifestyle businesses. Some individual angels may occasionally invest in lifestyle businesses but, if there is cash flow, professional investors need you to return capital.
VC Funds. Everyone always gets excited about VC funds. These are professional investors who can write significant checks to companies. Now VC funds, opposite to angels, are not investing their own money. Although some may put some of their own personal money, they also raise money from other investors, Limited Partners. These LPs give them money so they can produce an IRR target, a certain return on an annual basis. LPs invest in multiple funds, across different assets, and they are always looking for the best performing funds. So if you put yourself in the shoes of the fund manager or general partner, not only do they have to be one of the better venture capital funds, they have to return more than anyone else out there in the market in order to capture the attention and commitment of these LPs. They are not looking for startups that can provide a 5x or 10x return. They are looking for startups that can provide a return that will cover their entire fund. As you think about approaching this type of investor, you first have to believe that your startup can provide that level of return. Since VCs are professional investors, they tend to have a pretty set structure on what they like to invest in and how they make decisions. Before approaching them, know what type of investments they make, and in what sectors and business models. Most importantly, know what stage you fall under.
Crowdfunding. Another type of early stage capital is crowdfunding websites. There are two ways in which crowdfunding works. One, you can list your company and hope investors will fund you. There are several sites offering this type of service where, subject to a few things they have to check off to make sure you are not committing fraud, they’ll just put your company up and people just start sending money your way. Then there is crowdfunding that can be done via syndicate. This is one person, kind of like an angel, who says, "hey, we are going to invest in this," and then they get people to follow along. There are private syndicates and public syndicates. A couple of warnings before you crowdfund, know that money doesn’t always follow. Crowdfunding is often considered a last resort. If you decide to go this route, just be careful not to add too many people to your cap table. Having too many investors this early on can turn into a real challenge when it comes to managing communications and reporting in the future.
Non-dilutive Capital. Although it’s not really a type of investment or investor, we do want to also talk about non-dilutive capital. These are basically grants. There are Government grants, better known as (SBIR), pitch grants, foundation grants, etc. These are great ways to get early stage capital without having to dilute your company. The thing to keep in mind here is how time consuming these can be. Too often we see companies become professional grant writers as opposed to good business owners. They get good at winning pitch competitions or getting grants awarded, but they forget to make money and grow their company through revenue. Winning competitions and receiving government funding shouldn’t be confused with actual growth. The purpose of grants is to help you launch not be a sustainable source of revenue or income for your company.
Nontraditional Funds. Given that VC is focused on very specific types of companies, there are other types of funds that are starting to emerge such as Revenue Based Investment funds and equity buy back funds. We won’t be getting into those on this particular blog but you can read more about them here.